An angel investor is a wealthy individual who uses their own money to invest in small businesses. A venture capitalist, on the other hand, is an individual or firm that makes a similar investment using money pooled from other companies, corporations, and pension funds. Venture capitalists do not invest their own money. In many cases, venture capitalists need angel investors to understand businesses with great potential from a very early stage.
Understanding angel investors
The angel investor provides capital to an early-stage start-up in exchange for equity or convertible debt. Some angel investors will also provide mentorship and advice, while others form syndicates and collectively invest in businesses.
Most angel investors are accredited by the Securities Exchange Commission (SEC) provided they meet one of two conditions:
- Their annual income was at least $200,000 for the past two years. This increases to $300,000 if the individual files taxes with a spouse.
- They have a minimum net worth of $1 million, excluding the value of their primary residence.
When Amazon was a startup, for example, Jeff Bezos received $300,000 from his parents and a further $1 million from twenty wealthy investors who contributed $50,000 each.
Note that angel investors serve as the bridge between the initial financing needs of a startup and more significant capital requirements as it grows. They are focused on helping the entrepreneur build their business and, at least initially, are less concerned with making a profit.
Angel investor advantages
Angel investors tend to be less risk-averse than traditional financial institutions. In most cases, they do not expect to be paid back if the venture they are financing fails.
Entrepreneurs also benefit from the wealth of industry knowledge and experience that many such investors bring to the table.
Understanding venture capitalists
Venture capitalists are employees of venture capital firms that invest using money from other companies, large corporations, and pension funds.
While angel investors are a critical early source of funding, venture capitalists provide funding for more established startups to help them transition through various growth stages into mergers, acquisitions, or IPOs.
Venture capitalist investment also tends to be more significant, with a single investment typically in the range of $3-5 million and lasting around a decade. In return, venture capitalists expect to be involved in operations and may request a seat on the board of directors.
In 2005, Facebook founder Mark Zuckerberg received a Series A funding round from venture capitalists worth $12.7 million.
Venture capital advantages
Venture capital funding is ideal for businesses that want to scale quickly. Like angel investment, there is generally no expectation that the money is paid back if the business fails.
Some venture capitalists are also well connected. In other words, they have a vast network of professional contacts that the startup can access to secure additional funding or recruit experienced talent.
Key takeaways:
- An angel investor is a wealthy, accredited individual who uses their own money to invest in small businesses. A venture capitalist is an individual or firm that invests the money of other companies, corporations, and pension funds.
- Angel investors provide capital to early-stage start-ups in exchange for equity or convertible debt. They may also provide mentorship and play a critical role in sustaining the operations of early-stage startups.
- Venture capitalists invest significant sums of money over longer timeframes to help startups undertake mergers, acquisitions, or IPOs. In exchange, many venture capital firms request a seat on the startup’s board of directors.
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